Originally published in the News Star and the Shreveport Times on Sunday, August 28, 2016.
Question: A friend of mine approached me about investing in a start-up business he’s involved in. I am not at liberty to divulge any details, but I think the idea is brilliant. I really don’t see how it can miss. My question is, what is the best way for me to make this investment – personally, through my IRA or with an LLC I set up?
Answer: Whoa boy. You’re about 100 steps ahead of the parade and it might not even be going your way.
First of all, you don’t see how it can miss? You just told me this is the first time you’ve ever invested in a business.
Because business success is never the result of a single good idea. Those are a dime a dozen. Business success is about good ideas…plus strategy, plus execution, plus management …and a bit of luck never hurts.
Here are a few things to think about before you invest a dime:
Are you an investor or self-employed? It’s one thing to invest in your own business and quite another to be an investor. If you invest in your own business, you are self-employed. This is the business which pays you a salary and from which you make your day to day living. Investing in your business, or being self-employed, certainly carries a level of risk, but typically not the same risk as investing in someone else’s business (idea).
If you are a plumber, you’re going to have to buy equipment with which to ply your trade. But if you know what you are doing, and have a few customers, it is unlikely that investment is going to be flushed down the toilet (I’m sorry, I just had to do that).
On the other hand, investing in someone else’s start-up business idea is something in which you have very little knowledge or ultimate control. Your risk is likely far higher.
What is the track record? Is the key person (or people) responsible for the success of the potential business experienced in start-ups, or is this her first time? It is possible to have a great idea and a lousy business. I’d rather see a boring idea run as an excellent business.
Who else is doing this? Do you know others who are investors in this business? Does anyone in this deal have a track record of investing in successful start-ups? If so, ask that person how many times their investments have turned out well, and how many have ended up worthless. Because…
Are you willing to lose all your money? That’s not exactly the positive thinking most people want to hear at the front end of an exciting new venture, but it is a question every investor must ask. No one wants to lose a dime, but if you lost 100% of the money you invest, would it change your life?
What is your friendship worth? This is directly connected to the “lose all your money” question above. Soured business deals can ruin friendships, especially when it comes time to spreading around the blame for failure. Are you willing to take that risk with this friendship, or can it survive the loss?
You asked about business forms from which to invest. The LLC (limited liability company) is the most common form offering some protections. You could visit with your attorney about that.
Investing your IRA money in a start-up is probably not even an option unless you find a very cooperative IRA trustee that would help you set up something called a self-directed IRA. And then there’s the cost…
I’m less concerned about the way you make this investment (personally, LLC or IRA) than the why.
For sure, don’t invest a dime you cannot afford to lose.
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